Ask CryptoVantage: How Risky is Bitcoin Compared to Stocks?

Calculating Volatility

A common method for calculating the risk of an investment is to calculate its volatility. Volatility is a measure of how much the price of an asset fluctuates in a given period of time. In general, the more the price of an asset fluctuates, the riskier it is as an investment. Investments with high volatility are often “high risk high reward” type investments.

If you are considering investing in a highly volatile asset over the long-term, a good rule of thumb is to look at the long-term trend of the asset price – it may be highly volatile day-to-day day, but over multiple years it could be trending upwards or downwards.

Bitcoin is considered a highly volatile asset. The following chart shows the 1-year volatility of bitcoin versus US stocks. Bitcoin is represented by the blue line at the top and US stocks are represented by the purple line. This chart shows that bitcoin is considerably more volatile than US stocks.

From this chart you can draw the conclusion that bitcoin is a higher risk investment than stocks. Note that in this article, when we refer to US stocks, we are talking about the aggregate stock market (e.g. S&P 500), and not individual stocks.

Bitcoin Volatility vs US Stocks (http://charts.woobull.com/)

Bitcoin Returns

Even though bitcoin has been a high-risk investment, its returns have been higher than almost any other asset over the past 5-10 years. The following chart shows the relative performance of bitcoin versus US stocks in recent years. Bitcoin’s returns are shown in blue, and US stocks are shown in orange.

Despite bitcoin’s volatility being higher than that of US stocks, the chart below shows that the returns have been much higher. When considering how risky an investment is, you must also consider the trade-off between volatility and returns. In other words, you need to assess the risk versus reward. A common metric that represents this trade-off is the Sharpe ratio.

The Sharpe Ratio

The Sharpe Ratio is a measure of an asset’s returns versus the volatility/risk. It considers the “excess returns” of the asset (the difference between the amount this asset returns, and what you could have earned in a risk-free investment) over some period of time, and the volatility of the asset over that same period of time.

The result is a value that can be used to compare the risk-adjusted return between different assets. A higher Sharpe Ratio indicates better returns relative to the amount of risk involved in the investment. Take a look at this video for a more in-depth explanation of how the Sharpe Ratio is calculated.

The chart below shows the Sharpe Ratio of bitcoin compared to US stocks. Bitcoin is shown in orange this time, and US stocks in blue. The chart confirms that even though bitcoin has been the riskier investment (highly volatile), the returns have more than made up for the level of risk.

It is important to note that the Sharpe Ratio is a historic representation of how these assets have performed. It can be used as an indication of what might be expected, but it is not predictive of what will occur. Regardless of what the Sharpe Ratios shows, remember to factor in your level of risk tolerance when choosing your investments.

Bitcoin Risk Adjusted Returns vs US Stocks (http://charts.woobull.com/)

Key Takeaways

• Bitcoin is a more volatile and riskier asset than US stocks.
• Bitcoin has provided a much better return than US stocks over the past 5-10 years.
• The Sharpe Ratio can be used as an indication of risk adjusted returns of various assets, and a higher Sharpe Ratio indicates better returns relative to the amount of risk involved in the investment.
• Bitcoin’s Sharpe Ratio is higher than that of US stocks, indicating that bitcoin investments yield high returns relative to the risk.
• The Sharpe Ratio is a measure of historic risk-adjusted return (and does not predict future performance) so always consider your risk tolerance when choosing your investments.